Deciding to buy an investment is often much easier to do than hitting the sell button, but every investor must sell sometimes. Faith Glasgow runs through those moments when it might be time to say goodbye.
A lot of column centimetres are given over to the question of what to buy and when to invest into your ISA, especially at this time of year as the tax year end looms.
Much less is written or said about the question of when to sell out of existing holdings. Yet a robust sell discipline is just as central to successful investing. Hold on to a fund or investment trust too long in spite of the warning signs, and you could lose heavily, as the many investors who stuck with Neil Woodford as he shifted his UK equity income fund progressively into unquoted companies know all too well.
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So, what signs should you be alert to that it may be time to sell or reduce a holding? Some are to do with formal changes in the way the fund is run, others with much more subtle shifts in its focus or with the macroeconomic backdrop. Others again concern your own portfolio and investment needs. All aspects are important.
For many investors this is a key reason to sell: why hold on to a fund that isn’t delivering, if you can buy something similar that is? Professional investors may make a judgement after a certain period of underperformance – say two consecutive quarters – or a certain amount of loss, on the grounds that it’s important to have a strict sell discipline.
But if you’re going to assess underperformance, it’s crucial to get under the bonnet of your fund to find out why it’s not delivering and ensure you compare it against genuinely similar peers.
Often, it’s not the individual fund that’s in difficulties, but wider economic or market conditions that are working against the investment style (value underperformed growth for much of the last decade), market cap subsector (for instance small companies funds as interest rates rose last year), or even the whole sector (remember property funds in the aftermath of Brexit?). In such cases, peer funds will be suffering too.
But being out of fashion does not mean a manager has lost their touch. For instance, Baillie Gifford remains an impressive manager within the high-growth equity space – but it’s bound to go through periods of underperformance such as the present.
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On the whole it’s a bad idea to sell a fund on the basis of its poor performance relative to peers alone, especially on a short-term perspective. But if underperformance persists and the manager shows no sign of taking action to remedy it, then it may make sense.
As Gavin Haynes, co-founder of Fairview Investing, observes: “Everyone sees short-term blips in performance. More than one year and I will get concerned, and two years will trigger a sell.”
2) Fund manager change
If the manager changes, do review your holding in that fund. “However, this won’t necessarily trigger a sale: each fund needs to be looked at in its own right,” stresses Haynes.
With a clearly defined investment process in operation, careful succession planning and a strong team in place, a longstanding lead manager can retire or depart without disrupting the running of the fund.
But there will be instances when an individual is seen as the key driver of performance and a sudden departure would cause concern (Terry Smith at Fundsmith being an obvious example).
However, Haynes believes, “there is less willingness these days to simply rely on a ‘star manager’ (not helped by the Woodford debacle), and it is more common for fund groups to have more than one individual or a team in place to reduce key person risk”.
3) Investment strategy change
You’re paying an active fund manager to follow a clearly defined strategy; if they divert from this strategy, alarm bells should ring.
Haynes gives an example: “Style drift (where the fund manager shifts from their expected investment style) would certainly be a reason to sell the fund, as they would not be doing the job that you are paying them for.”
Increasing exposure to unquoted companies in an open-ended fund that originally focused on listed stocks would also give cause to reconsider your position, as the drift could make the fund less liquid and potentially more volatile. Jupiter recently reduced exposure to unquoted stocks in its funds, due to investor concerns.
4) Fund has grown too big
“Fund size has become much more of a key determinant when considering sell discipline in recent years,” says Haynes. “This is due to an increasing concentration of flows towards a small number of funds, as centralised buy lists and DIY platform recommendations have increasingly influenced fund selection.”
A successful fund can grow its assets under management rapidly, partly through organic investment growth and partly because it attracts new money. Size can translate into economies of scale for investors, and make the fund more viable and less likely to be wound up or taken over.
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But beyond a certain size, this may detract from its success. If a manager has to take a large stake in a company in order to hold a meaningful position, it may be hard to achieve and could cause liquidity problems and push the price down when they come to sell.
Rapid inflows can also make it difficult for open-ended fund managers to invest the money in a timely manner, which means they’re holding more cash until opportunities arise. Quality of investment ideas may also suffer.
“This is particularly important in less liquid parts of the stock market such as Smaller Companies and Emerging Markets,” says Haynes. Funds focusing on large-cap and mega-cap portfolios, and especially those that trade only rarely, are likely to be able to grow much bigger without running into this problem.
5) Macroeconomic changes
“A change in the top-down view on favoured markets is perhaps the most common trigger for selling a fund,” comments Haynes. The pandemic and the Russian invasion of Ukraine are two obvious examples of events that have changed the investment backdrop and led to sell signals for certain areas.
“In the same way, changes in investment styles (for instance, value versus growth) or in the economic climate to favour large or small companies will also result in me changing funds within my portfolio – although this may involve reducing exposure, as opposed to outright sales.”
6) You own too much
Received wisdom among most professional investors is that it’s a good idea to review your portfolio at least once a year, and as part of that exercise it makes sense to reduce your exposure to the most successful performers.
That may sound counterintuitive, but it’s about risk control and maintaining balance and diversity. The strongest-performing funds will be growing faster than the others and accounting for an increasingly large percentage of the total; if one takes a nasty hit, your overall returns will be more seriously hit.
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Think of Scottish Mortgage (LSE:SMT) last year. It had a massively successful few years, with shares gaining around 240% from March 2020 to its peak in late 2021; then over 2022 they lost 46% of their value.
If you had held the trust through the past decade and allowed it to gain ever more dominance in your portfolio without trimming your holding substantially, that fall would do serious damage to the whole.
By regularly trimming the success stories and using the cash to top up current underperformers, you’re not only reducing risk and positioning yourself for market change in due course, but also selling high and buying low - sound investment sense.
7) Your needs have changed
If your investment needs and goals change, you may well need to sell some holdings and buy others more appropriate to your new investment targets.
For instance, at retirement you might well want to reorient your portfolio towards income generation. That might mean selling some of the capital growth-focused funds and buying consistent, generous dividend-payers.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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